On Wednesday, the Bank of Canada hiked its benchmark interest rate by 50 basis points, the second consecutive large increase as the central bank strives to rein in soaring inflation. The raise brings the policy interest rate to 1.5 percent, a move that experts had foreseen and markets had factored in.
The Bank of Canada also signalled that more rate hikes are on the way, saying on Wednesday that it is “prepared to act more firmly if necessary to meet its commitment to attaining the 2% inflation target.”
In a statement announcing the decision, the central bank stated, “Canadian economic activity is strong, and the economy is plainly functioning in excess demand.”
“With the economy in oversupply and inflation remaining far above target and anticipated to grow in the near term, the Governing Council continues to believe that interest rates will need to rise even higher.”
In the midst of soaring inflation, the central bank has taken a bold approach to tighten monetary policy. The Consumer Price Index (CPI) has risen dramatically in recent months, reaching a three-decade high of 6.8% in April. Inflation is targeted at 2% by the Bank of Canada. The neutral range, where the interest rate is no longer stimulative, is believed to be between two and three percent.
That month, all eight key CPI components increased, with food and shelter prices increasing at a greater rate than in March. In April, Canadians paid about 10% more for food, the highest increase since September 1981.
In the short term, the Bank of Canada anticipates inflation to rise even further before beginning to drop. According to the report, nearly 70% of all CPI categories currently have inflation rates above 3%.
What the Economists Have to Say
The Bank of Canada is largely expected to raise its overnight rate by another 50 basis points in July, according to economists. However, the strong wording used in Wednesday’s statement raises the possibility of further severe hikes.
The central bank’s overall tone, according to Douglas Porter, chief economist at BMO Capital Markets, “is above and beyond hawkish.”
“They seemed to provide a suggestion that, while everyone expects another 50 basis point raise at the next meeting, they might be leaning toward something even greater,” he said.
“If not more than 50 basis points at the July meeting, then 50 basis points at the meeting beyond July. So, in general, I get the impression that the Bank’s anxiety is growing. They clearly underestimated inflation even at the most recent meeting, and they’re now attempting to make up for the lost time.”
A 50 basis point boost in July would meet the Bank’s definition of aggressive measures, according to CIBC economist Avery Shenfeld, but the Bank’s caution about moving “more forcefully if needed” goes counter to the projection that interest rate growth would slow by early October.
What to Expect for the Future
“Despite the quick tightening of financial conditions, a nasty streak of upside inflation surprises means the Bank is in no position to abandon its hawkish posture, and we don’t see any pushback against a third 50 basis point rate hike in July,” says Taylor Schleich of the National Bank of Canada.
The statement’s rate guidance, on the other hand, is likely to remain vague and flexible, simply stating that ‘interest rates will need to rise further.’
Indeed, the Bank is likely to leave markets guessing as to how much above 2% the terminal rate will rise and whether its base case includes hiking into restrictive territory (above 3%).”
The Potential for a Hike Above 50 BPS
“With both growth and inflation tracking above forecasts…it may push a greater feeling of anxiety at the Bank of Canada toward speeding rate hikes,” said Scotiabank’s Derek Holt. “If I were them, I wouldn’t be so sure that a larger move in June isn’t necessary.” Under current circumstances, the Bank of Canada’s policy rate should be at neutral—and beyond—let alone months or quarters from now.”
However, others believe that the bank might rear itself in. “The Bank of Canada will likely avoid anything more than a 50-bps raise, calling it a bridge too far,” says Jimmy Jean of Desjardins. While it’s easy to dismiss that rationale when inflation is hovering around 7%, central bankers have expressed their displeasure. As a result, a 50-bps rate hike appears to be a foregone conclusion.
Expect another 50 basis point hike in July before policymakers revert to a more cautious monetary tightening stance later this year.
Will There be Additional Rate Hikes After This Week?
“Any acknowledgement that the housing market is already responding to rising interest rates should also be interpreted as an admission that excess demand is about to become less excessive,” says Andrew Grantham of CIBC.
“That is one of the main reasons why we believe the pace of rises will decrease after another 50 basis point boost in July, and the Bank will not need to raise rates above the 2.5 percent midpoint of its neutral band to target 2% inflation by 2023,” he continues.
How Will This Impact Canada’s Housing Market
“We believe the significant decline in [housing] activity in April indicates a turning point for the Canadian market, with additional cooling on the way,” says RBC’s Robert Hogue. ” The Bank of Canada’s decision to aggressively normalize its monetary policy is a game-changer for the market, transforming what had been a huge tailwind into a strong headwind.”
“Rising interest rates are supposed to slow the economy by making borrowing more expensive,” says Toni Gravelle, Deputy Governor of the Bank of Canada.
“This tends to stifle growth in certain industries, such as housing. However, because highly indebted households would face significant debt-servicing expenses, this deceleration may be accentuated this time around. As a result, household spending will likely be reduced more than it would have been otherwise.”
He concluded that “a slowdown in housing activity is part of our base-case scenario. However, greater borrowing and unsustainable high property prices may cause a slower-than-expected slowdown.”
The Potential for Rate Cuts in the Future
“I believe the BoC will be more cautious than the market forecasts [in 2022],” says Dave Larock, a mortgage broker at Integrated Mortgage Planners. “Furthermore, if the Bank raises rates more than predicted, I believe this will greatly enhance the chances of a recession and subsequent rate reduction.”
“The possibility of the Bank of Canada reversing rates in the next five years increases with every BoC boost,” says Rob McLister, rate expert and editor of MortgageLogic.news.
“By the time 2024 rolls around and we’ve had a year and a half of uninspired growth, we see reasonable cause to expect interest rate decreases,” says the National Bank of Canada. “That’s exactly what happened the last cycle when the Fed was compelled to lower rates after hiking to 2.50 percent in tandem with a liquidity-draining QT exercise.”